Excess Cashflow Hierarchy
May 22, 2024
by a searcher from Rice University - Jesse H. Jones Graduate School of Business in Houston, TX, USA
I'm looking to better to understand how cash flow is typically distributed in a self funded SBA deal early in the life of the business.
Given the following simplistic hypothetical deal:
$3M Purchase Price
$1M EBITDA
Source of Funds:
80% SBA Loan
10% Seller Note
10% Equity
SBA Loan:
$2.4M Starting Balance (80%)
$415K Annual SBA Payment (12% Rate over 10 years)
Seller Note:
$300K
$30K Annual interest only payment (10% Rate)
Equity
$100K Searcher
$200k Investor
Assume all common equity for simplicity
$1M EBITDA -> $385K cashflow (after accounting for debt payments and ~$170K Taxes)
Ignoring keeping it in retained earnings / reinvesting in the business (which I know is a big assumption) - is there a standard to how this gets allocated to the SBA, Seller Note, or equity holders? As the searcher it obviously in my best interest to pay this out as investor return, and I believe that the SBA generally allows distributions to equity holders as long as SBA loan payments are current/ within covenant. I also struggle with the concept of a standby seller note if I can distribute to equity holders, but not pay off a seller note before the SBA.
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
How you end up handling it also has to do with the expectations you set with your investors up front. If you agree to distribute a portion of excess cash flow to your equity investors they are going to expect that. If you indicate to your equity investors you intend to accelerate the elimination of debt or plan to hold some excess cash flow back in reserve to cover future required debt payments and they agree to that, then you can certainly do that. I think the key is go into the situation setting the right expectations for your equity investors. I hope this helps. If you have additional questions you can reach me here or directly at redacted
from The University of Chicago in Chicago, IL, USA
1. Packing order as you have specified is correct. In non-SBA lending, no equity holder cannot get any distributions except to cover PTE taxes. And subordinate notes cannot be pre-paid before the senior lender.
2. As ^redacted has said you cannot have "required" payments to investors. He also says you can make distributions to equity holders from excess cash flow. On this, see SBA comments below.
3. When there is Seller Note, seller may restrict distributions to equity holders even from excess cash flow.
4. I asked SBA a question on distributions to equity holders after reading your post. Answer from SBA is below. OC stands for Operating Company.
Prior to disbursement, Lender must require Borrower and OC to certify (per SOP###-###-#### p###-###-#### ): i. Make any distribution of company assets that will adversely affect the financial condition of the Borrower and/or OC; This language appears to allow the Lender to restrict distributions by the borrower for specific purposes (personal tax liability). I could not find any other language addressing restrictions of distributions.
5. One could read above SBA comments as ....If the business runs into a problem, then prior distributions to equity holders, even from excess cash flow, could be against what the borrower signed with the lender. (assuming lender has the "certification" language per SOP).